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Investment Risk-> Are You Prepared for a Market Correction?

Posted by Larry Jones on Jan 10, 2019 9:30:00 AM
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Riding the Gravy Train

As last year came to a close it seemed that the message from the financial markets was that "happy days are here again." After one of the longest bull markets in the history of Wall Street, many were feeling that the sky is the limit when it comes to investing. 

I must admit that it's very hard to face the possibility of a downturn when portfolio statements are reflecting significant gains. I believe that most investors are, at heart, optimists, otherwise they wouldn't be investing, but sometimes our optimism may lead us astray. Ben Bernanke once famously commented that the market was showing an "irrational exuberance," a comment that I'm sure he soon regretted as the market reacted in a negative fashion to his remarks. 

Are we experiencing "irrational exuberance" once again?


Mr. Market

As we turn on our daily newscast we are always treated to a summary of how the stock market performed that day. Many people hang on every word of these market reports, as if nothing else matters. But just what exactly IS the market?

Quite simply, it's a collection of public companies that have decided to offer stock for sale in order to raise capital. The initial stock sale is known as an IPO, or "initial public offering." After the IPO, the stock shares are bought and sold in the secondary market. This is where the average investor operates. It's important to remember that what you own is, in reality, a little slice of a corporation, and your investment results are, in fact, tied to the fortunes of that particular firm. If you are invested in a mutual fund, then you are tied to a multitude of companies, but the concept is the same. What's my point? The value of your investment is directly tied to the value of the underlying company.

That's the bottom line.

But the beast that we know as the Stock Market is not always a rational animal. In fact, Wall Street, or Mr. Market, as I'll call him, can be a paranoid schizophrenic. Just like a Hollywood celebrtity, he believes all the hype generated about him. As folks begin to report that Mr. Market is invincible, so he begins to believe it too. And so do some investors. They ride the wave of Mr. Market's delusions and pat themselves on the back for their investing acumen!

But one day Mr. Market hears something that scares him a little bit. The next day he hears something else. Soon Mr. Market may begin to panic, and share prices fall, sometimes precipitously.

Has the value of the companies contained inside Mr. Market fallen precipitously? Probably not. Coca-Cola is still Coca-Cola and Microsoft is still Microsoft. These companies are still chugging along, and are still very healthy. It's just Mr. Market's delusional spasms that may be causing the investor to lose money. My point is that long-term investors should be more concerned with the underlying value of his stocks than with what all the talking-heads happen to be saying on any particular day. That's the secret to successful long-term investing.


Predicting the Market

Knowing that Mr. Market is a basket-case is useful information! This knowledge allows us, as investors, to sleep at night. After all, in my opinion, no matter what kind of delusions Mr. Market suffers, if we have value in our portfolio we can weather the storms.

Can we predict what the market is going to do? Only in the sense that it will do one of two things, it will either go up, or it will go down.

Let me say that again: the market will go up, and the market WILL go down. Can we predict exactly when these things will happen? Well, if I could do that I'd have been retired a long time ago.

Now, given that Mr. Market is performing at an all time high, and has been on the longest bull run ever, which way do you think it's likely to go? Up, or down?

Is your portfolio prepared no matter which way it goes?

Stay tuned....in the next post I'm going to discuss some things that we need to consider, especially as it involves investment risk and a possibly overvalued market.

Until next time,

Larry

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